The subdued stock price reaction suggests that Kingnet Network Co., Ltd.'s (SZSE:002517) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Examining Cashflow Against Kingnet Network's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2024, Kingnet Network recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of CN¥1.8b, well over the CN¥1.55b it reported in profit. Kingnet Network's free cash flow improved over the last year, which is generally good to see.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Kingnet Network's Profit Performance

Kingnet Network's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Kingnet Network's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 1 warning sign with Kingnet Network, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Kingnet Network's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.